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China Can’t Paper Over Yuan-Policy Contradictions
So long as the economic cycles of the U.S. and China are out of sync, Beijing’s dilemma will remain
By AARON BACK
Updated Jan. 25, 2016 3:48 a.m. ET
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The People’s Bank of China is trying to ease monetary policy without causing further depreciation pressure on the yuan. So long as China is even somewhat open to international capital flows, this is like trying to take a shower without getting wet.
According to leaked PBOC meeting minutes, the central bank is aware of the contradictions in its monetary-policy stance. That would explain the delay in using one of its usual easing tools: lowering banks’ level of required reserves. The fear is that unleashing reserves into the banking system would put more downward pressure on the currency.
So the central bank has been limited to short-term tools for injecting liquidity into the system. This trick may help get over the liquidity squeeze that typically accompanies the Lunar New Year holiday, when cash demand spikes. But it isn’t a sustainable solution. If the PBOC keeps pumping liquidity indefinitely, it will still lead to outflows.
Cracking down on capital flows could restore the PBOC’s ability to ease without sparking downward pressure on the yuan. But in an economy as open as China’s is today, this is easier said than done. Companies are adept at moving money in and out, disguised as trade flows.
More-draconian measures, such as lowering the $50,000 limit on individuals’ foreign-currency purchases, could spark a domestic panic. If the front door is shut, ordinary Chinese will look for a back door to get money out.
China could get a reprieve if the U.S. Federal Reserve delays rate increases. By arresting the upward momentum of the dollar, this would give the PBOC breathing room. But so long as the economic cycles of the U.S. and China are out of sync, Beijing will face the same dilemma. If China’s economy keeps getting worse, the only direction for the yuan is lower.
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